March 11, 2008

The Federal Reserve announced today an expansion of its securities lending program. Under this new Term Securities Lending Facility (TSLF), the Federal Reserve will lend up to $200 billion of Treasury securities to primary dealers secured for a term of 28 days (rather than overnight, as in the existing program) by a pledge of other securities, including federal agency debt, federal agency residential-mortgage-backed securities (MBS), and non-agency AAA/Aaa-rated private-label residential MBS. The TSLF is intended to promote liquidity in the financing markets for Treasury and other collateral and thus to foster the functioning of financial markets more generally. As is the case with the current securities lending program, securities will be made available through an auction process. Auctions will be held on a weekly basis, beginning on March 27, 2008. The Federal Reserve will consult with primary dealers on technical design features of the TSLF.

The kerfuffle over Bear Stearns yesterday shows that the market is prepared to believe anything, as long as it’s bad. Yes, times are tough. But they actually managed to scrape out a profit last year (Nov. 30 year end) and have $18-billion cash on the balance sheet thanks to a vigorous term issuance programme in which they haven’t been afraid to pay up for five year money. They’re not going to disappear overnight. Though mind you, as Naked Capitalismpoints out, they’re very highly levered:

With this in mind, why were Bear and Lehman so highly geared? Lehman is levered 40 to 1, Bear is geared 34:1 (by contrast, Carlyie is levered 32:1). Trading firms should know better.

In deteriorating debt markets, the last thing you want to be carrying is a big balance sheet. Perhaps the banks in question assumed that the Fed’s interest rate cuts would produce enough gains in value (due to lower prevailing rates) to make deleveraging less urgent.

But now Bear and Lehman (and no doubt their peers as well) are delevearging out of necessity, as mark-to-market losses force them to write down assets, leading to hits to equity, and then putting them at gearing levels that are untenable. So shrink they must.

And, mind you, if I was thinking about buying their stock, I wouldn’t be counting on a return to pre-2007 earnings anytime soon. Neither would Punk Ziegel.

“The key problem is not the write-offs and losses that the company must take in the just-ended first fiscal quarter. The key issue is building a new business model,” Bove said. “Bear Stearns must adjust and it is probably going to be forced to find a merger partner,” he added.

Joseph Lewis, the second-largest shareholder in Bear Stearns Cos., may add to his holdings after the stock fell on speculation the company lacks sufficient access to capital, a person close to him said.

Well … I’m not an economist and I have a high degree of skepticism towards any macro-forecast anyway … but if I had to bet a nickel I’d bet on a long grinding recession that squeezes every last bit of leverage out of the system. The credit markets are thoroughly disfunctional, borrowers are extending term to stay alive (Bear Stearns, CIT, …) rather than to expand and these funds are staying on the balance sheet as cash at a negative carry (Bear Stearns, CIT, …). I don’t know what will happen tomorrow, but I can say it looks pretty ugly out there today!

The Bloomberg story confirms our cynicism about the S&P’s and Moody’s. It reports that the rating agencies have held back from downgrading AAA subprime related securities.

Why is this important? In most deals, roughly 80% is of the value of the transaction was in the AAA tranches. These are far and away the most important in terms of economic value. But, not surprisingly, many of the buyers of this paper did so because they had portfolio constraints or capital requirements that made top-rated instruments particularly desirable. Thus in many cases, downgrades of this paper would have a pronounced impact, leading in many cases to sales, depressing prices.…

The ratings methods balance estimated losses against so-called credit support, a measure of how likely it is that owners of each piece of the bond will incur losses. For AAA rated debt, credit support needs to be five times the expected losses, according to Sylvain Raynes, author of The Analysis of Structured Securities, a college textbook.

All but six of the 80 AAA ABX bonds failed an S&P test for investment-grade status, which requires credit support to be twice the percentage of troubled collateral. The guideline was one of four tests used by S&P, and a failure to meet the standard wouldn’t have automatically resulted in a downgrade. The other companies used similar metrics to grade bonds, Raynes said. Investment grade refers to all bonds rated above BBB- by S&P and Baa3 by Moody’s….

On a $118 million Washington Mutual bond issued in 2007, WMHE 2007-HE2 2A4, 5.6 percent of its loans are in foreclosure and its safety margin, or the debt available to absorb losses, is less than the combined total of its loans at risk. Both S&P and Moody’s rate it AAA.

Fitch rates that bond B, five levels below investment grade and 15 levels less than its rivals….

“We have built in 20 percent more home price declines from the end of ’07,” said Glenn Costello, managing director for residential mortgage-backed securities at Fitch. “When you build in that much home price decline, I feel good when I pick up the paper and I see that home prices are only down another 3 percent. My ratings are still good.”

These bad decisions, in turn, have resulted in the collapse of many investment vehicles: more than 100 collateralised debt obligations (CDOs) and structured investment vehicles (SIVs) have already entered the murky post-event of default (EOD) state. This number will grow in the coming weeks.

Unfortunately, the legal documents that govern these transactions are so poorly written – full of ambiguities, inconsistencies, “circular references” and worse, contradictions – that many investors, trustees and respective legal advisors do not know how to interpret them.

BCE’s spreads widened on expectations that the company’s LBO will go ahead. A Quebec Court threw out a bondholder lawsuit that alleged the takeover of the Canadian telecoms company by an investment consortium was unlawful.

Volume returned to the preferred market today and was actually relatively heavy – the first time that’s happened in a while! I don’t know quite what to make of the price and volume activity in the PWF/GWO issues … there’s no news that I can see – it may just be a single manager re-jigging his portfolio. Or random chance!

Note that these indices are experimental; the absolute and relative daily values are expected to change in the final version. In this version, index values are based at 1,000.0 on 2006-6-30

Index

Mean Current Yield (at bid)

Mean YTW

Mean Average Trading Value

Mean Mod Dur (YTW)

Issues

Day’s Perf.

Index Value

Ratchet

5.46%

5.47%

33,714

14.69

2

+0.6357%

1,095.5

Fixed-Floater

4.75%

5.54%

65,192

14.81

8

+0.3328%

1,046.7

Floater

4.73%

4.81%

85,992

15.75

2

-0.2826%

865.8

Op. Retract

4.84%

3.11%

75,909

2.93

15

-0.1809%

1,042.9

Split-Share

5.32%

5.67%

97,130

4.04

14

+0.3192%

1,033.5

Interest Bearing

6.17%

6.52%

68,570

4.23

3

+0.6168%

1,086.7

Perpetual-Premium

5.76%

5.45%

282,678

7.74

17

+0.0534%

1,023.3

Perpetual-Discount

5.46%

5.52%

261,975

14.61

51

-0.0211%

942.6

Major Price Changes

Issue

Index

Change

Notes

GWO.PR.E

OpRet

-3.6399%

Now with a pre-tax bid-YTW of 4.97% based on a bid of 24.62 and a softMaturity 2014-3-30 at 25.00.

GWO.PR.H

PerpetualDiscount

-2.1885%

Now with a pre-tax bid-YTW of 5.55% based on a bid of 21.90 and a limitMaturity.

CM.PR.H

PerpetualDiscount

-1.1765%

Now with a pre-tax bid-YTW of 5.80% based on a bid of 21.00 and a limitMaturity.

PWF.PR.K

PerpetualDiscount

-1.0480%

Now with a pre-tax bid-YTW of 5.53% based on a bid of 22.66 and a limitMaturity.

WFS.PR.A

SplitShare

+1.0152%

Asset coverage of just under 1.7:1 as of March 6, according to Mulvihill. Now with a pre-tax bid-YTW of 5.80% based on a bid of 9.95 and a hardMaturity 2011-6-30 at 10.00.

BCE.PR.R

FixFloat

+1.0417%

BCE.PR.B

FixFloat

+1.0417%

BNS.PR.M

PerpetualDiscount

+1.0427%

Now with a pre-tax bid-YTW of 5.35% based on a bid of 21.32 and a limitMaturity.

FBS.PR.B

SplitShare

+1.1579%

Asset coverage of just under 1.6:1 as of March 6, according to TD Securities. Now with a pre-tax bid-YTW of 5.94% based on a bid of 9.61 and a hardMaturity 2011-12-15 at 10.00.

MFC.PR.A

OpRet

+1.2785%

Now with a pre-tax bid-YTW of 3.89% based on a bid of 25.35 and a softMaturity 2015-12-18 at 25.00.

BSD.PR.A

InterestBearing

+1.5991%

Asset coverage of 1.6+:1 as of March 7, according to Brookfield Funds. Now with a pre-tax bid-YTW of 6.90% (mostly as interest) based on a bid of 9.53 and a hardMaturity 2015-3-31 at 10.00.

W.PR.H

PerpetualDiscount

+1.6352%

Now with a pre-tax bid-YTW of 5.70% based on a bid of 24.24 and a limitMaturity.

BNA.PR.C

SplitShare

+2.2947%

Asset coverage of 3.3+:1 as of January 31, according to the company. Now with a pre-tax bid-YTW of 7.03% based on a bid of 20.06 and a hardMaturity 2019-1-10 at 25.00. Compare with BNA.PR.A (5.67% to call 2008-10-31) and BNA.PR.B (7.71% to hardMaturity 2016-3-25).

Volume Highlights

Issue

Index

Volume

Notes

PWF.PR.J

OpRet

100,272

Desjardins crossed 100,000 at 26.10. Now with a pre-tax bid-YTW of 3.79% based on a bid of 26.08 and a call 2010-5-30 at 25.00.

PWF.PR.D

OpRet

94,410

Nesbitt crossed 60,000 at 26.49. Now with a pre-tax bid-YTW of –7.46% based on a bid of 26.41 and a call 2008-4-10 at 26.00. Will yield 4.02% if it makes it to the softMaturity 2012-10-30 at 25.00.

PWF.PR.K

PerpetualDiscount

29,300

Nesbitt crossed 25,000 at 22.70. Now with a pre-tax bid-YTW of 5.53% based on a bid of 22.66 and a limitMaturity.

RY.PR.G

PerpetualDiscount

28,030

Now with a pre-tax bid-YTW of 5.37% based on a bid of 21.16 and a limitMaturity.

TD.PR.O

PerpetualDiscount

24,831

Now with a pre-tax bid-YTW 5.23% based on a bid of 23.45 and a limitMaturity.

There were thirty-three other index-included $25-pv-equivalent issues trading over 10,000 shares today.

5 Responses to “March 11, 2008”

OK, this is not a backhanded shot, or any intended negative remark; it is a question that needs clarification. This issue, to me, was controversial right from the get-go. The press was full of how this issue was well-received, over-subscribed, greenshoe fully exercised within a day, etc. Beyond that, the virtually identical TD.PR.Q, although trading down from about $25.75 went to $25.25ish, and even today last traded at $25.10.

I haven’t seen the prospectus, but I will presume that the underwriters have a .75 / share commission on this issue. If this is correct (or close to being correct), then it makes sense for them to continue to sell any inventory at any price over $24.25; indeed $24.90 is a great price . . . for them.

At some point, the underwriter’s inventory will dry up, and the R’s will probably start to trade closer to the Q’s. Hence, there is a buying opportunity here.

My new question then is this: when’s the best “buy-in” [or average down!] point here?!

Given that the greenshoe was exercised the day after announcement, I don’t think the underwriters have anything left in inventory. My guess is that since there was such a similar comparator available at time of issue (TD.PR.Q) a big whack of this issue was bought by hot money (both institutional & retail) who didn’t have the slightest intention of holding it … they just wanted to sell at $25.25 at the opening.

You might be right on with that . . . I’ve been on this all morning, and the offering under $25 seems to be drying up. Based on the 500k shares already traded (11:00AM), there’s strong, but not really substantial bids from $24.85 to the current bid of $24.93. If we get a few more buyers hitting the offer, history could show that $24.85 was the basic “opening day” low, and hence, the ultimate short-term buying opp. At this particular moment, the offer is BMO with an iceberg at $24.95, followed by Canaccord with substantial (showing) offering at $24.97. Strategically, the place I would say to be bidding right now is $24.86. Time will tell!